One of the most influential analysts in the tech sector is sounding the alarm on the group given its sky-high valuation and deteriorating earnings outlook.
According to Toni Sacconaghi of AB Bernstein, “risk is increasing in tech, especially with high-priced stocks.”
And when this analyst issues a warning, investors would be smart to heed his message.
Sacconaghi has frequently been rated the top tech analyst in Institutional Investor magazine’s annual rankings, and his picks in the space have had an average twelve-month return of 21%, making him among the best analysts on Wall Street.
“Part of tech’s challenge is that it is comping against a tough 2018,” Bernstein said. “Tech’s earnings lagged the broader market last year, as tax reform more favorably impacted other sectors and expectations for 2020 don’t improve dramatically.”
Tech stocks have dominated the market’s bull run over the last ten years, but these stocks are getting far too expensive and their earnings picture continues to look bleak.
The sector is now trading at 21.4 times forward earnings, the highest level in 15 years, according to Sacconaghi. And this rapid multiple expansion—which has become especially pronounced this year—has reached an alarming level given that earnings are predicted to have a “startling” fall over the next twelve months.
“The largest stocks are emblematic of current year tech struggles: among the 17 largest cap tech companies, seven have flat to negative forward earnings growth,” Sacconaghi wrote. “In particular, overall earnings growth is expect to be double digit negative for Semiconductors and Tech Services.”
It’s anticipated that earnings for the tech sector will drop by 9.9 percentage points on an equal-weighted basis in the next year, compared with the broader market’s 1.3 percentage point decline, according to Sacconaghi.
The revenue picture is looking scary as well with the group expected to grow just 0.5% compared to the overall market, which is expected to gain 4.7% in sales, the analyst said. Earnings, meanwhile, could see declines of 990 basis points on an equal weighted basis in the next 12 months – far higher than the market’s expected decline of 130 basis points.
While Sacconaghi is cautious about the tech sector’s sky-high valuations and grim earnings picture, the analyst hasn’t written off the group completely. On the contrary, he recommends investors consider cheaper names in the sector.
“While collective valuations are high, fundamentals for tech remain strong,” Sacconaghi wrote, pointing to the group’s above average five-year growth expectations.
Bernstein maintained its market weight rating on tech and encouraged investors to be cautious on “expensive names with decelerating growth or low quality scores, currently concentrated in technology services and mid-cap software,” Sacconaghi wrote.
The firm also scanned for those quality stocks in the space with relatively low valuations. Among the stocks that made the list, Applied Materials (NASDAQ: AMAT), Dell Technologies (NYSE: DELL), Lam Research (NASDAQ: LRCX), and Skyworks Solutions (NASDAQ: SWKS).
Wall Street is bullish on all four stocks, and analysts’ average price targets suggest possible upside of 8% for Skyworks Solutions, 15% for Applied Materials, 21% for Lam Research, and 27% for Dell Technologies over the next twelve months.